DA ITAD BIR Ruling No. 069-07

May 23, 2007 DA ITAD BIR RULING NO. 069-07 Article 12 (Royalties) Old Philippines-Sweden tax treaty; Article 12 (Royalties) Renegotiated Philippines-Sweden tax treaty; BIR Ruling Nos. DA-ITAD 115-06, 112-05, 157-05, 136-04, 58-02 and 12-02 Panasonic Mobile Communications Corporation of the Philippines 102 Laguna Boulevard, Laguna Technopark Barrio Don Jose, Sta. Rosa Laguna 4026 Attention: Mr. Marlon M. Molano General Manager Gentlemen : This refers to your letter dated October 4, 2005, requesting confirmation that royalties to be paid by Panasonic Mobile Communications Corporations of the Philippines (Panasonic Philippines) 1 to Telefonaktiebolaget LM Ericsson (Ericsson Sweden) on January 1, 2004, and thereafter, are subject to 15% income tax, pursuant to Article 12 (Royalties) of the renegotiated Convention between the Republic of the Philippines and the Kingdom of Sweden for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income of June 24, 1998 (renegotiated Philippines-Sweden tax treaty) , whose provisions on taxes apply on income derived or which accrued beginning January 1, 2004. In relation, you also request for a refund of allegedly overpaid income taxes on royalties paid by Panasonic Philippines to Ericsson Sweden in May, August, and November, 2004, amounting to PHP8,019,229.82, which were subject to 25% income tax under the old Convention between the Republic of the Philippines and the Kingdom of Sweden for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income of May 7, 1987 (old Philippines-Sweden tax treaty) , instead of 15% under the renegotiated tax treaty. BASIC FACTS It is represented that Ericsson Sweden is a corporation organized and existing under the laws of Sweden, with address at Torshamngatan 23, S-164 80, Stockholm, Sweden, and Organization No. 556016-0680, as evidenced by its Articles of Association; that Ericsson Sweden is engaged in carrying on workshops on business and trade, in acquiring, setting-up, and carrying on and trading in electric and other plants, and in carrying on other activities; that Ericsson Sweden is not registered as a corporation or as a partnership in the Philippines, as confirmed by the Certificate of Non-Registration of Corporation/Partnership dated August 4, 2005, issued by the Securities and Exchange Commission; that, on the other hand, Panasonic Philippines is a corporation, organized and existing under the laws of the Philippines, with address at 102 Laguna Boulevard, Laguna Technopark, Barrio Don Jose, Sta. Rosa, Laguna, Philippines; and that Panasonic Philippines is registered with the Philippine Economic Zone Authority as an Ecozone Export Enterprise (as confirmed by its Registration Agreement dated October 31, 2001, and amended Certificate of Registration No. 01-064 dated June 3, 2003), to engage in (1) the manufacture of amplifiers, cartridges, 3.5 floppy disk drives, black and white and colored monitors and rear-view monitors, charged couple devices, sequential switchers, audio portable four-bus mixers, camera drive units (PS), portable wireless audio products, GSM cellular phones and parts and accessories, ECM cartridges for mobile phones, digital CCTV color camera (video surveillance equipment), and ETC system including parts and accessories thereof, and (2) the undertaking of the central office sales and documentation function for the supply of floppy disk drives of the Matsushita Group of Companies at Laguna Technopark Special Economic Zone. ATICcS It is further represented that on September 25, 2003, Ericsson Sweden entered into a Global Patent License Agreement (Agreement) with Panasonic Mobile Communications Company, Ltd (Panasonic Japan) , a corporation organized and existing under the laws of Japan with address at Saedo-Cho, Tsuzuki-Ku, Yokohama City, 224-8539, Japan, and who has Affiliates 2 worldwide including Panasonic Philippines ; that under the Agreement, Ericsson Sweden granted Panasonic Japan a worldwide, nontransferable, non-exclusive license under the Ericsson Licensed Patents 3 to make, have made, use, sell, offer for sale, lease or otherwise dispose of Panasonic Products, 4 all operating under the applicable standards; that Panasonic Japan shall have the right to grant sublicenses of such rights to its Affiliates only, who shall agree to be bound in all respects to all the obligations in the Agreement, including but not limited to the payment of royalties, for which Panasonic Japan is originally bound to; and that the Agreement shall be effective on September 25, 2003, and shall continue for the License Period 5 unless otherwise terminated. Moreover, it is represented that on September 25, 2003, Panasonic Japan and Panasonic Philippines entered into a Memorandum of Agreement (Memorandum) whereby Panasonic Japan granted Panasonic Philippines the license it originally acquired from Ericsson Sweden under the Global Patent License Agreement; that under the Memorandum, Panasonic Philippines shall also pay royalties to Ericsson Sweden equivalent to 0.55% of the Net Selling Price of the Panasonic Products sold globally by Panasonic Philippines which are compliant with any or more of the standards of GSM, GPRS and EDGE; that the payment shall be done through wire transfer, on the first day of March, June, September, and December of any calendar year; and that the Memorandum shall be effective on September 25, 2003, and shall remain to be effective unless otherwise terminated. RULING A. On income tax In reply, please be informed that the royalties to be paid by Panasonic Philippines to Ericsson Sweden on the Ericsson Licensed Patents are subject to the reduced income tax rates under the respective Article 12 (Royalties) of the old Philippines-Sweden tax treaty for royalties paid from September 23 to December 31, 2003, and of the renegotiated Philippines-Sweden tax treaty for royalties paid on January 1, 2004 and thereafter , thus: Old Philippines-Sweden tax treaty : "Article 12 ROYALTIES 1. Royalties arising in a Contracting State and paid to a resident of the other Contracting State may be taxed in that other State. 2. However, such royalties may also be taxed in the Contracting State in which they arise, and according to the law of that State, but if the recipient is the beneficial owner of the royalties, the tax so charged shall not exceed a) 15 per cent of the gross amount of the royalties, where the royalties are paid by an enterprise registered with and engaged in preferred areas of activities and also royalties in respect of cinematographic films or tapes for television or broadcasting and royalties for the use of, or the right to use, any copyright of literary, artistic or scientific work; b) in all other cases, 25 per cent of the gross amount of the royalties." Renegotiated Philippines-Sweden tax treaty : "Article 12 ROYALTIES 1. Royalties arising in a Contracting State and paid to a resident of the other Contracting State may be taxed in that other State. 2. However, such royalties may also be taxed in the Contracting State in which they arise and according to the laws of that State, but if the beneficial owner of the royalties is a resident of the other Contracting State, the tax so charged shall not exceed 15 per cent of the gross amount of the royalties." Accordingly, royalties to be paid by Panasonic Philippines to Ericsson Sweden on the Ericsson Licensed Patents before January 1, 2004, or before the effectivity of the renegotiated Philippines-Sweden tax treaty, cannot be subject to 15% under paragraph 2 (a), Article 12 of the old Philippines-Sweden tax treaty because Panasonic Philippines , being the enterprise paying the royalties, is not registered with and engaged in preferred areas of activities, 6 nor are such royalties paid in respect of cinematographic films or tapes for television or broadcasting or for the use of, or the right to use, any copyright of literary, artistic or scientific work. Thus, such royalties to be paid by Panasonic Philippines to Ericsson Sweden before January 1, 2004, are subject instead to 25% income tax based on the gross amount thereof under paragraph 2 (b), Article 12 of the old Philippines-Sweden tax treaty. (BIR Ruling No. DA-ITAD 58-02 dated April 24, 2002) CTDHSE On the other hand, royalties to be paid by Panasonic Philippines to Ericsson Sweden on the Ericsson Licensed Patents on January 1, 2004, and thereafter, are subject to 15% income tax based on the gross amount thereof under paragraph 2, Article 12 of the renegotiated Philippines-Sweden. (BIR Ruling No. DA-ITAD 136-04 dated November 24, 2004) B. On value-added tax Under Section 108 (A) (1) of the National Internal Revenue Code of 1997 (Tax Code), the use or the right to use of the Ericsson Licensed Patents in the Philippines by Panasonic Philippines is subject to value-added tax (VAT), thus: "Section 108. Value-added Tax on Sale of Services and Use or Lease of Properties . (A) Rate and Base of Tax. There shall be levied, assessed and collected, a value-added tax equivalent to ten percent (10%) of gross receipts derived from the sale or exchange of services, including the use or lease of properties The phrase 'sale or exchange of services 'shall likewise include: xxx xxx xxx (1) The lease or the use of or the right or privilege to use any copyright, patent, design or model, plan, secret formula or process, goodwill, trademark, trade brand or other like property or right;" 7 Under Section 105 of the Tax Code, the VAT, being an indirect tax, may be shifted or passed on to Panasonic Philippines by Ericsson Sweden, thus: "SEC. 105. Persons Liable . Any person who, in the course of trade or business, sells, barters, exchanges, leases goods or properties, renders services, and any person who imports goods shall be subject to value-added tax (VAT) imposed in Sections 106 to 108 of this Code. The value-added tax is an indirect tax and the amount of tax may be shifted or passed on to the buyer, transferee or lessee of the goods, properties or services. . . " aTcIEH However, under Section 109 (q) of the Tax Code, certain transactions are exempt from VAT if they are so exempt under international agreements to which the Philippines is a signatory or under special laws, thus: "SEC. 109. Exempt Transactions . The following shall be exempt from the value-added tax: xxx xxx xxx (q) Transactions which are exempt under international agreements to which the Philippines is a signatory or under special laws, except those under Presidential Decree Nos. 66, 529 and 1590;" 8 With respect to special laws that are significant to Panasonic Philippines and other enterprises registered with the Philippine Economic Zone Authority (PEZA), Republic Act No. 7916 (An Act Providing For The Legal Framework and Mechanism For The Creation, Operation, Administration, And Coordination Of Special Economic Zones in the Philippines, Creating For This Purpose, The Philippine Economic Zone Authority (PEZA), And For Other Purposes) (particularly Section 24 thereof) and its Implementing Rules and Regulations thereof (particularly Section 1, Rule XIV [Incentives to ECOZONE Developers/Operators] thereof) provide: "Section 24. Exemption from Taxes Under the National Internal Revenue Code . Any provision of existing laws, rules and regulations to the contrary notwithstanding, no taxes, local and national, shall be imposed on business establishments operating within the ECOZONE. In lieu of paying taxes, five percent of the gross income earned by all business and enterprises within the ECOZONE shall be remitted to the national government. . . "Section 1. ECOZONE Developers/Operators . ECOZONE Developers/Operators shall be entitled to the following incentives: A. Exemption from National and Local Taxes and Licenses. An ECOZONE Developer/Operator shall to the extent of its construction and operation, be exempt from payment of all national internal revenue taxes and local government impost, fees, licenses or taxes, including but not limited to the following: 1. Internal revenue taxes such as gross receipts tax, value-added tax, ad valorem and excise taxes; 2. Franchise, common carrier or value added taxes and other percentage taxes on public and service utilities and enterprises." As an incentive to Panasonic Philippines and other PEZA-registered enterprises, Republic Act No. 7916 provides that such enterprises are liable only to the payment of 5% of their gross income in lieu of all national and local taxes including VAT. This being so, the transaction between Panasonic Philippines and Ericsson Sweden involving the use or the right to use of the Ericsson Licensed Patents that give rise to the royalties will be treated as exempt 9 from VAT. (BIR Ruling No. DA-ITAD 112-05 dated September 30, 2005) The same conclusion is reached in VAT Ruling No. 100-99 dated September 16, 1999, involving PEZA-registered enterprises, where this Bureau ruled: "In the case of payment for royalties to a non-resident owner, the responsibility for withholding the VAT and paying the same rests on the payor. However, since PEZA-registered export enterprise may not be passed on with nor claim input VAT, then payment of royalties to a non-resident lessor, . . . , should be as it is hereby confirmed to be, exempt from VAT." (BIR Ruling No. DA-ITAD 112-05 dated September 30, 2005) And in the recent Supreme Court ruling, Commissioner of Internal Revenue versus Seagate Technology (Philippines) (G.R. No. 153866) dated February 11, 2005, also involving PEZA-registered enterprises, where the Supreme Court ruled: "Applying the special laws we have earlier discussed, respondent as an entity is exempt from internal revenue laws and regulations. This exemption covers both direct and indirect taxes, stemming from the very nature of the VAT as a tax on consumption, for which the direct liability is imposed on one person but the indirect burden is passed on to another. Respondent, as an exempt entity, can neither be directly charged for the VAT on its sales nor indirectly made to bear, as added cost to such sales, the equivalent VAT on its purchases. Ubi lex non distinguit, nec nos distinguere debemus . Where the law does not distinguish, we ought not to distinguish. Moreover, the exemption is both express and pervasive for the following reasons: First, RA 7916 states that 'no taxes, local and national shall be imposed on business establishments operating within the ecozone. Since this law does not exclude the VAT from the prohibition, it is deemed included. Exceptio firmat regulam in casibus non exceptis . An exception confirms the rule in cases not excepted; that is, a thing not being excepted must be regarded as coming within the purview of the general rule. Moreover, even though the VAT is not imposed on the entity but on the transaction, it may still be passed on, therefore, indirectly imposed on the same entity a patent circumvention of the law. That no VAT shall be imposed directly upon business establishments operating within the ecozone under RA 7916 also means that no VAT may be passed on and imposed indirectly. Quando aliquid prohibetur ex directo prohibetur et per obliquum . When anything is prohibited directly, it is also prohibited indirectly." (BIR Ruling No. DA-ITAD 115-06 dated September 27, 2006) This ruling is issued on the basis of the facts as represented. However, if upon investigation it shall be disclosed that the actual facts are different, then this ruling shall be without force and effect insofar as the herein parties are concerned. Further, for the purpose of giving due course to the refund of alleged overpaid income taxes on royalties withheld by Panasonic Philippines on behalf of Ericsson Sweden , a copy of this ruling and a copy of the docket thereof will be furnished to the Revenue District Office which has jurisdiction over Panasonic Philippines , who will act on such request for refund. Very truly yours, Commissioner of Internal Revenue By: (SGD.) JAMES H. ROLDAN Assistant Commissioner Legal Service Footnotes 1. Formerly, Matsushita Communication Industrial Corporation of the Philippines. 2. Affiliate shall mean a company or other legal entity which is under control by Panasonic Japan, but any such company or other legal entity shall be deemed to be an affiliate only as long as such control exists, and for the purposes of this definition, "control" shall mean direct or indirect ownership of more than fifty percent (50%) of the voting power, capital or other securities of controlled entity. For the purpose of the Agreement, Affiliate shall include the joint venture Sony Ericsson Mobile Communications AB and any of its Affiliates (hereinafter collectively referred to as "Sony Ericsson"), Ericsson India Ltd., Beijing Ericsson Mobile Communication Co., Kuwait Ericsson Telecommunication Equipment and Services, Panasonic Mobile & Automotive Systems Czech, (PMACZ), Panasonic Mobile Communications Corporation of the Philippines (PMCP) and Panasonic Putian Communications Beijing Company, Ltd. (PMCB) for as long as Ericsson Sweden, Panasonic Japan and/or Matsushita Electric Industrial Company Ltd. (the parent company of Panasonic Japan) (as applicable) owns at least 40% of the shares of such company. Should, due to domestic legal requirements within the home country of such mentioned companies, it would not be possible for Ericsson Sweden, Panasonic Japan and/or Matsushita Electric Industrial Company Ltd. to own as much as 40% of the shares of such mentioned corporations, such are irrespective included in the definition of Affiliates if the ownership of such shares are remaining as of the maximum extent possible under such local law and regulation. 3. Ericsson Licensed Patents shall mean (i) all Patents owned by Ericsson Sweden and its Affiliates (Affiliates shall be for the purpose of this definition be exclusive of Sony Ericsson), and (ii) the Ericsson patents listed in Appendix 1 of the Agreement, including its patent families worldwide, (existing and future patents, existing and future licensable patent applications, such as existing and future divisions, continuations, continuations in part, reissues, renewals and extensions thereof). 4. Panasonic Products shall mean: (i) Panasonic Japan (and/or its Affiliates) branded or operator branded End-User Terminals, and (ii) Modems and Modules, which are infringing upon any Ericsson Licensed Patents and which are compliant with any or more of the Standards. 5. License Period shall mean the period commencing on September 25, 2003, and having a duration through the expiration of the last one of the Ericsson Licensed Patents/Panasonic Licensed Patents, however, only for as long as there are any Panasonic Products and Ericsson Products sold or otherwise disposed of by an applicable Party (and/or its Affiliates). 6. In BIR Ruling No. DA-ITAD 12-02 dated January 29, 2002 , this Bureau ruled that the phrase "enterprise registered and engaged in preferred areas of activities" as used in the old Philippines-Sweden tax treaty and other Philippine tax treaties refers only to an enterprise registered with the Board of Investments and does not include an enterprise registered with the Philippine Economic Zone Authority (PEZA) like Panasonic Philippines. The ruling took into account the nonexistence of Republic Act No. 7916 (An Act Providing for the Legal Framework and Mechanism for the Creation, Operation, Administration, and Coordination of Special Economic Zones in the Philippines, Creating for this Purpose, the Philippine Economic Zone Authority (PEZA), and for Other Purposes) at the time of signature of these treaties. 7. Republic Act No. 9337 (An Act Amending Sections 27, 28, 34, 106, 107, 108, 109, 110, 111, 112, 113, 114, 116, 117, 119, 121, 148, 151, 151, 236, 237 And 288 Of The National Internal Revenue Code Of 1997, As Amended, And For Other Purposes), which was signed into law on May 24, 2005 and became effective on November 1, 2005, amended Section 108 (A), thus: "SEC. 108. Value-added Tax on Sale of Services and Use or Lease of Properties. (A) Rate and Base of Tax. There shall be levied, assessed and collected, a value-added tax equivalent to ten percent (10%) of gross receipts derived from the sale or exchange of services, including the use or lease of properties selling price or gross value in money of the goods or properties sold, bartered or exchanged, such tax to be paid by the seller or transferor: Provided, that the President, upon the recommendation of the Secretary of Finance, shall, effective January 1, 2006, raise the rate of value-added tax to twelve percent (12%), after any of the following conditions has been satisfied: (i) Value-added tax collection as a percentage of Gross Domestic Product (GDP) of the previous year exceeds one and one-half percent (1-1/2%); or (ii) National government deficit as a percentage of GDP of the previous year exceeds one and one-half percent (1-1/2%). The phrase 'sale or exchange of services' means the performance of all kinds of services in the Philippines for others for a fee, remuneration or consideration. . . . " The VAT rate was increased to 12% on February 1, 2006, in accordance with the Memorandum of the Executive Secretary to the Secretary of Finance dated January 31, 2006, as circularized by Revenue Memorandum Circular No. 7-2006 (Publishing the Full Text of the Memorandum from Executive Secretary Eduardo R. Ermita dated January 31, 2006 Approving the Recommendation of the Secretary of Finance to Increase the Value Added Tax Rate from Ten Percent to Twelve Percent) dated January 31, 2006. 8. Republic Act No. 9337 renumbered and amended Section 109 (q) to read as: "SEC. 109. Exempt Transactions. (1) Subject to the provisions of Subsection (2) hereof the following transaction shall be exempt from the value-added tax: xxx xxx xxx (K) Transactions which are exempt under international agreements to which the Philippines is a signatory or under special laws, except those under Presidential Decree No. 529;" 9. When a transaction is exempt , Ericsson Sweden will not subject to VAT (output tax) the royalties for the Ericsson Licensed Patents to be paid to it by Panasonic Philippines , and Ericsson Sweden is not allowed any tax credit on VAT (input tax) on purchases it previously paid, if any. (Section 4.109-1, Revenue Regulations 16-2005 [Consolidated Value-Added Tax Regulations of 2005]).